ETFs and Bitcoin

Tyler and Cameron Winklevoss’ two-year effort to gain SEC approval for what would have been the first US-approved Bitcoin Exchange Traded Fund (ETF) was dealt its final blow in July when the SEC voted 3-1 against approval. The twin brothers 2016 proposal, if approved, would have allowed Bats Global Markets to list and trade shares of the “Winklevoss Bitcoin Trust,” which buys, provides custody and secures Bitcoin.

ETF shares, which were introduced in 1993, are securities that trade like equity shares of stock. Rather than representing ownership in a company, however, they represent ownership in a basket of securities like stocks, bonds, a basket of foreign currency, or a basket of commodities like oil, gold or (potentially) Bitcoin. They are a low-cost, easy-entry vehicle for diversifying portfolios, and have no minimum investment requirement. In the US alone an estimated $2 trillion has been invested in ETFs since their introduction, with around 2,000 different offerings currently available in the market.

ETF approval in the US is a lengthy process. From the time a new fund proposal is published in the Federal Register, the SEC has up to 240 days to render an approval or denial decision. While the commission doesn’t always take the full 240 days, they often do, especially when the proposal involves a new asset class like Bitcoin.

There are four proposals for Bitcoin ETFs currently before the SEC. Three are for futures-based ETFs, including both a long and short fund proposed by NYSE/ProShares, a long and short fund submitted by CBOE/GraniteShares, and five leveraged funds proposed by NYSE/Direxion. The fourth proposal, and the one that’s drawn the most public interest, is for a physically-backed Bitcoin ETF put forward by CBOE/SolidX/VanEck.

Final decisions are due within the next month for all three futures-based proposals, with NYSE/ProShares due by August 23rd, CBOE/GraniteShares by September 15th and NYSE/Direxion by September 21st.

Futures-based Bitcoin ETFs aren’t likely to significantly affect Bitcoin’s price, as the funds buy futures contracts rather than Bitcoin. Many believe, however, that the approval of a physically-backed Bitcoin ETF such as CBOE/SolidX could result in the same kind of increased demand and rise in price that gold experienced after the introduction of gold ETFs. Aside from the distinct difference of gold being a physical metal and Bitcoin existing digitally, as investable commodities the two are not dissimilar. The primary challenge for gold and Bitcoin involve acquisition, storage and security. Gold ETFs gave retail investors and institutions the ability to invest in physical gold without having to acquire, store or secure it. Similarly, a Bitcoin ETF would allow investment in bitcoin without having to navigate a cryptocurrency exchange, create a bitcoin wallet or secure the asset, making Bitcoin vastly more accessible.

The CBOE physical Bitcoin ETF is a collaboration between VanEck and SolidX, two firms which had previously submitted ETF proposals individually. SolidX proposed a physical Bitcoin ETF which was rejected by the SEC in March of 2017. VanEck proposed a futures-based ETF but withdrew the application in January when the SEC requested withdrawal of all Bitcoin ETF proposals. The SEC has since issued public notices outlining their concerns with Bitcoin ETFs, instructing potential applicants on the criteria they’ll consider for approval, and has worked closely with exchanges making new offers, including CBOE. The SolidX/VanEck joint-effort seeks to improve upon the Winklevoss proposal in several ways.

The SEC’s main issues with Bats/Winklevoss were that it didn’t address concerns about Bitcoin market structure, the lack of existing regulation, and the potential for price manipulation. To address these concerns, VanEck created an index of registered, US-based OTC desks which require KYC/AML and execute trades by voice rather than electronically. CBOE contends that this eliminates much of the manipulation that takes place on electronic exchanges. To address the market surveillance issue the SEC had with the Winklevoss ETF, CBOE cites their membership in the Intermarket Surveillance Group (ISG) which gives them access to information regarding trading of SolidX shares and listed Bitcoin derivatives by ISG members and affiliate exchanges. CBOE has also entered into a comprehensive surveillance sharing agreement with Gemini Exchange. SolidX shares have been priced at around $200,000, making them available only to accredited investors and institutions, as this addresses SEC concerns regarding availability to retail investors. The commission had custody concerns with the Winklevoss proposal as well, but the SolidX fund has a syndicate of A-rated insurers that cover theft, hack, or any other operational risk.

The CBOE/SolidX proposal is generally considered much stronger than Winklevoss and time will tell whether it adequately addresses the SEC’s concerns and meets the investor protection standards they’re tasked to enforce. As expected, the commission recently delayed a decision on SolidX until September 30th, after which they’ll very likely extend the approval deadline twice more and utilize the full 240 days available for consideration. By rule, final decision must be made by February 27th, 2019.

August 23rd is the imminent date of importance as a final decision is due on the NYSE/ProShares proposal, and it will likely set the tone for the remaining three Bitcoin ETF rulings. The recent decision on the Winklevoss appeal could only consider evidence and markets from the original denial in March 2017. The decision on the ProShares ETF, however, should provide insight into the SEC’s current position, and may indicate the likelihood of any Bitcoin ETF approval.